Defensive To Remain In Limelight

Defensive To Remain In Limelight

With the Sensex recovering nearly 50 per cent from its March lows it is becoming a risky proposition for investors and traders to bet on high beta stocks. Low beta stocks could do the trick in the current market situation. Defensive stocks once again may lead the market rally as the craze for the financials and high beta stocks fizzles out slowly. Yogesh Supekar and Geyatee Deshpande explain why it makes sense to park extra monies in defensive stocks while the DSIJ Research Team churns out the best contenders in the defensive space to beat the markets

Sensex and Nifty, key benchmark indices that are the barometer of the health of the Indian equity markets, have risen almost 46 per cent each since their March 23, 2020 lows. Such a sudden and record-breaking rise, though financially satisfying, has got experts worried – the single biggest concern being ‘valuations’. The valuations are way too far-stretched to not predict a market correction. If we simply look at the PE levels for 2020 in all the months, we get a fair idea.

If we look at the above table, we see that the PE has expanded steadily since the correction in March. One might say that the PE has been the highest in August at 30.38 for 2020. That may not seem very informative per se but when we realise that the Nifty PE has never been so high ever, it can be an alarming piece of information for both traders and investors. Even in 2008, when the markets were pumped up by liquidity and frenzied leveraged buying, the PE for Nifty in January 2008 was 25.33. The correction pushed the PE for Nifty towards 12.73 in January 2009 and eventually when the markets recovered, the PE clawed back to the 25.33 levels by October 2010.

Thus, we saw the PE contract by almost 50 per cent following which it expanded from the lows by nearly 100 per cent. In 2020, in spite of the voracious fall, the PE contracted from 27.96 to 20.38, indicating a 30 per cent contraction. In the wake of a recovery, Nifty is eventually trading at the 30.38 level, indicating a 50 per cent expansion in PE since April 2020. Needless to say, the current price recovery in markets is without the support of recovery in earnings and hence the valuations could be unsustainable in the near term.

So, either the earnings have to grow fast or the prices should correct to bring valuations to fair levels. Robust earnings’ growth owing to slower economic growth and the pandemic situation looks far more difficult than a price correction. Also, the data compiled by Bank of America suggests that S & P 500 has averaged a loss of 0.03 per cent between August and October since 1928, making it a worst three-month period for the broader market index. The data also highlights July to be the best month historically for S & P 500 if we study the results since 1928.

Taking the Lead

Sensex made its 2020 highs on January 14 at 41,952 and is down by almost 10 per cent since then. In the same period, BSE IT index was up by almost 12 per cent. As many as 48 IT stocks are trading higher than they were on January 14, indicating the broader outperformance of IT stocks in spite of severe pandemic-led correction. Some of the IT bellwether stocks such as Infosys, TCS, Wipro, HCL Technologies and Larsen and Toubro Infotech feature in the list of stocks that surpassed their pre-pandemic level stock prices. Similarly, pharmaceutical stocks showed a tremendous rally in tough times. As many as 57 pharmaceutical stocks are trading higher or above the pre-pandemic level stock prices. The average returns of 67 pharmaceutical stocks considered for the study touched 58 per cent since January 14, 2020 when the Sensex was at its peak in 2020. 

If history were to repeat itself, we are set for a muted market for the next three months starting August. Hence, switching to defensives can be most profitable tactical portfolio move for investors. Whenever a price correction in markets is expected, time and again it is realised that defensives lead the market. Actually, 2020 belongs to defensives. For obvious reasons, pharmaceutical stocks have rallied and so have the IT stocks. Both these sectors along with FMCG have been least impacted by the lockdowns. The table below highlights the outperformance of these three sectors on an YTD basis.

The quarterly earnings have been positive for IT companies. Hexaware Technologies, Tata Elxsi, Indiamart Intermesh, Infosys, Larsen and Toubro Infotech and Mindtree are just some of the IT entities that have come out with positive results this season, thus keeping investors’ interest in IT companies at an elevated level. In the pharmaceutical sector, companies such as Laurus Lab, Torrent Pharmaceuticals, Ajanta Pharmaceuticals, Piramal Enterprises, Alkem Lab, Cadila Healthcare, Aarti Drugs, Sanofi India, Alembic Pharmaceuticals, Divi’s Lab, Granules India and Zydus Wellness impressed investors with positive results, thus raising investors’ confidence in the sector.

The pharmaceutical stocks have rallied considerably and hence are not cheap any more but investors have to understand that these scrips are rallying after almost five years’ underperformance. Hence, the steady price performance may continue a little longer than investors’ expectations. In fact, the Indian pharmaceutical sector is expected to be stable for the remaining part of the year. A positive factor is that the production-linked incentives for API manufacturers are intended to reduce dependence on imports from China.

It is expected that the Indian pharmaceutical industry will register growth of 14.2 per cent in the second quarter of the current financial year. The first quarter saw the industry grow by 4.8 per cent. This growth was primarily in the anti-infective segment due to the outbreak of many diseases. The recent introduction of Rs 10,000 crore bulk drugs’ park and productionlinked incentives for API manufacturers augur well for the pharmaceutical industry as they will reduce supply disruptions in the long run. Almost 53 critical APIs are covered under the scheme, which are currently highly import-dependent.

Conclusion

As rich market valuations and the recent run up makes investing in high beta stocks a risky proposition, there is a strong case for defensives to again take market leadership. There are abundant stock-picking opportunities in sectors such as pharmaceuticals, IT and FMCG even as the rest of the market turns expensive. Time and again we have seen defensives come to the rescue of investors whenever the markets have been faced with correction. Zero leverage or low leverage is important in the current market condition. A portfolio with low beta stocks and stocks belonging to the defensive sector that have not yet participated in the current market rally could be given higher weightage in the portfolio.

It should be noted by investors that the weightage of oil and gas, IT, FMCG and pharmaceutical sectors in Nifty index has increased by 367, 334, 140 and 107 basis points to 16.2 per cent, 16.1 per cent, 12.6 per cent and 3.2 per cent, respectively. The weightage of finance and banking has come down by 143 and 739 basis points to 10.2 per cent and 23 per cent respectively. Thus, even in the case of Nifty, defensives are influencing the market performance more than they used to at the beginning of the year. We expect the momentum in defensives to continue a bit more even as defensive stocks continue to be in high demand. Looking at the valuations and growth opportunities we believe the following defensive stocks may outperform Sensex in the coming quarters. 

Godrej Consumer Products CMP (Rs ) : 683.50

BSE Code : 532424 I  Face Value (Rs ) : 1 I  Mcap FF (Cr.) :25,858.05 I  52 Week High / Low : Rs 771.75 /425.10

Investors would do well to take a closer look at Godrej Consumer Products Limited (GCPL), which is a low beta stock with improving margins. The company is a leader amongst India’s FMCG companies, manufacturing reputed household and personal care products. GCPL’s product range includes soaps and talc with leading brands like Cinthol, Fair Glow, Evita and Vigil. Under its hair care product segment, GCPL has brands such as Colour Soft, Anoop, Renew, Godrej Expert and Kesh Kala. As far as its fabric care business segment is concerned, the company has products like Godrej Dish Wash, Glo, etc.

Up 85 per cent of the company’s global portfolio consists of household insecticides, hygiene and ‘value for money’ products which have delivered an impressive 9 per cent growth for the quarter on a constant currency basis. GCPL’s India sales grew at 5 per cent. The combined portfolio of household insecticides and hygiene grew 20 per cent with household insecticides clocking 27 per cent growth and hygiene products delivering 15 per cent growth for the quarter.

Strong product innovation and development led to 15 per cent growth in the hygiene business segment aided by 45 product launches across geographies. The company is operating at 90 per cent of its production capacity in India and is also scaling up alternate channels while responding with agility to supply chain challenges. GCPL is doubling up on e-commerce and chemists’ channels in Africa, USA and the Middle East while also strengthening its engagement with salons and stylists.

GCPL’s net sales increased by 8 per cent on QoQ basis to Rs 2,327.34 crore while the operating profits or PBDIT excluding other income were declared at Rs 472.71 crore for quarter ended June 2020, down by 0.80 per cent from the previous quarter. The net profit jumped to Rs 394.88 crore in June 2020 from Rs 229.90 crore in March 2020 i.e. an increase of 71.76 per cent. The operating margins however decreased from 22.34 per cent to 20.45 per cent, i.e. a decline of 1.89 per cent on a QoQ basis.

Consumers do not want to take any chances with their health and vigilance against mosquitoes at a time when cases of malaria and dengue have gone up. This augurs well for the various products of GCPL. Even though the RoE for GCPL is not as high as some of its peers in the FMCG space, it is improving and the margins are also steady despite the ongoing crisis. While the loss of dominance in its hair colour business and weak execution in the African business remains a concern for the company, the valuations do not look stretched for GCPL as they do for other FMCG companies.

The stock is trading at PE of 46.17 as compared to the average industry PE of 62.61. Almost 626 FII accounts hold 26.79 per cent in the company while 82 different mutual fund schemes hold 1.58 per cent in the company with promoters holding as high as 63.24 per cent stake. The dividend yield for GCPL stands at 0.87 per cent while the DE stands low at 0.17. In one year, the GCPL scrip has gone up by 8.6 per cent, thus outperforming the Sensex by 4.94 per cent while underperforming the sector by 16.38 per cent. The stock carries a beta value of 0.63 with the Sensex and thus provides comfort to investors.

This is on account of the fact that high growth and low beta stocks with positive cash flows are just some of the qualities investors should look for while buying stocks in the wake of the markets having risen by 46 per cent since the lows of March. Strong resurgence in the household insecticides’ segment, new product launches in the hygiene segment across different geographies, relatively attractive valuation, low beta value and ramping up in production capacity are just some of the reasons why we believe investors should BUY this stock.

Tech Mahindra CMP (Rs ) : 681.35

BSE Code : 532755 I  Face Value (Rs ) : 5 I  Mcap FF (Cr.) : 42,135.91 I  52 Week High / Low : Rs 845.70 / 470.25

Tech Mahindra Limited is engaged in the business of computer programming, consultancy and related services. Its segments include IT services and business process outsourcing (BPO). The company’s telecom business provides consulting-led integrated portfolio services to customers, which are telecom equipment manufacturers, telecom service providers and IT infrastructure services as well as BPO and enterprise services (banking, financial services and insurance), retail and logistics and manufacturing, among others, of IT and IT-enabled services delivered through a network of various locations around the world. Its enterprise solutions business provides IT services, including IT-enabled services, application development and maintenance, consulting and enterprise business solutions, extended engineering solutions and infrastructure management services.

In terms of consolidated quarterly financial trends, the company’s net sales for Q1FY21 increased by 5.24 per cent to Rs 9,106.30 crore as compared to Rs 8,653.00 crore for Q1FY20. For Q1FY21, PBDT stood at Rs 1,666.30 crore, thus expanding by 3.5 per cent from Rs 1,610 crore for Q1FY20. The company gained net profit of Rs 955.50 crore in Q1FY21, which is a decrease by a mere 0.15 per cent compared to the net profit of Rs 956.90 crore gained in Q1FY20. On an annual basis, Tech Mahindra reported net sales of Rs 36,867.70 crore for FY20, an increase by 6.12 per cent compared to net sales of Rs 34,742.10 crore posted for FY19.

The PBDT for FY20 stood at Rs 6,509.10 crore, thus contracting by 3.4 per cent as against Rs 6,736.90 crore posted for FY19. In FY20, Tech Mahindra gained net profit of Rs 3,902.90 crore, which is 10.37 per cent lower than the net profit of Rs 4,354.30 gained in FY19. Tech Mahindra reported deal wins worth USD 300 million during the quarter ended June 2020, with USD 100 million worth of communication contracts and USD 190 million in the enterprise space. According to the company’s management, the drop in profits in the recent quarter was related to 25 per cent on the supply side while the remaining 75 per cent was from the demand side.

The supply side constraints are assumed to be resolved now. The company’s growth and recovery is expected to be positive. Also, its deal signing is expected to gain pace in the coming quarters. Tech Mahindra seems to be continuing to put more focus on improving its operating margins through FY21 on the back of cost rationalisation, delivery efficiency, portfolio entity synergy and increasing business growth in low-yield geographies. Considering the company’s growth potential, our recommendation is to BUY the scrip.

Cadila Healthcare CMP (Rs ) : 405

BSE Code : 532321 I Face Value (Rs ) : 1 I Mcap FF (Cr.) : 10,365.39 I 52 Week High / Low : Rs 411.60 / 206.45

Cadila Healthcare, also known as Zydus Cadila, is one of India’s leading pharmaceutical companies. It is primarily a manufacturer of generic drugs and manufactures a large range of pharmaceuticals as well as diagnostics, herbal products, skin care products and other OTC products. Starting from late 2015, having concluded a voluntary license agreement with Gilead Sciences Inc., the company also produces generics for Hepatitis C treatment, i.e. Sofosbuvir, which is distributed under the brand name SoviHep. The company makes active pharmaceutical ingredients at its three plants in India at Ankleshwar, Vadodara and Patalganga.

On the quarterly consolidated financial front, the company posted net sales of Rs 3,549.30 crore for Q1FY21, rising by 4.2 per cent when compared to net sales of Rs 306.20 crore posted for QFY20. For Q1FY21, PBDT came in at Rs 770.20 crore, thus expanding by 36.2 per cent from Rs 565.50 crore reported for Q1FY20. Cadila Healthcare gained net profit of Rs 469.90 crore for Q1FY21, which is an increase by 49.27 per cent compared to net profit of Rs 314.80 crore gained in Q1FY20. During FY20, the company’s net sales rose by 8.34 per cent to Rs 13,812.10 crore from Rs 12,748.40 crore reported for FY19. For FY20, the PBDT stood at Rs 2,191.90 crore, thus contracting by 37.22 per cent when compared to Rs 2,980.70 crore for Q1FY20.

The company gained net profit of Rs 1,175.60 crore in FY20, which is a decrease by 36.52 per cent from the net profit of Rs 1,851.80 crore gained in FY19. In February 2020, the company announced the launch of developing a potential DNA-based vaccine from a live attenuated recombinant measles virusvectored vaccine for the treatment of corona virus. Further, in July 2020, the company got permission to conduct human trials of the developmental vaccine named ZyCoV-D from the Drugs Controller General of India (DCGI), Government of India. The company is also among the several Indian pharmaceutical companies that have received licensing agreements from Gilead Sciences to produce Remdesivir.

It is now working on Interferon Alpha 2b for the treatment of corona virus-infected patients with moderate symptoms and is also developing Desidustat for improving oxygenation in blood at the behest of the Mexican regulatory authority. Furthermore, new launches are expected which will aid the company in maintaining steady growth. Currently, the pharmaceutical industry is riding on huge growth potential in the coming years and Cadila Healthcare may hugely benefit from it with its leadership position in the industry on account of a welldiversified product portfolio and strong consumer base. Hence, our recommendation is to BUY the scrip.
(Closing price as of August 10, 2020)

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